6 Questions To Ask About Variable Annuities
June 16, 2015 by LifeHealthPro
Like any financial tool, a variable annuity can be a great addition to your client’s portfolio. Used properly, it can help manage the amount of taxes they’re paying on your money while also providing growth and security for their retirement years. There are some nuances, however, that you may not be aware of. Here are some questions you should ask about any VA contract your clients are considering, or possibly those that they already have from prior advisors.
1. How much is deducted in fees per year?
Variable annuities, unlike the fixed variety, are a security, and money placed into them will in some form be invested into the market via a subaccount, which typically mirrors an existing mutual fund.
Just like a mutual fund, those subaccounts have annual fees attached to them. A typical variable annuity will also include other fees, such as M&E expenses. Any riders granting additional benefits may carry fees as well. Not all of these expenses are always outlined clearly in the contract and may only be listed in the prospectus — a dense, lengthy document that can be daunting to read.
All told, these fees average out in the 3 to 4 percent range on most contracts, meaning that a year when the contract gains 8 percent — a pretty good year by most standards — only nets a gain of 4-5 percent.
While this doesn’t mean that the VA is a bad choice, be sure to add up all of the fees being deducted each year so that you have a realistic expectation for the contract value.
2. How long is the surrender?
At first blush, this may seem like an obvious subject to cover. However, with variable annuities, unlike the fixed variety, you have a bit more freedom in how long the contract’s surrender period will be. This is because, among other things, while fixed annuities are ultimately tied to the same market forces as other safe vehicles such as bonds, the subaccounts in variable annuities are much more varied. This results in far more options available to you, namely much shorter surrenders than are typically found in the fixed world.
By choosing a shorter contract, you can keep the option open to move the money later on if your client’s needs change or the market changes — this mobility can be a big factor in an annuity purchase, and one we’ll talk about more a bit later on.
It is even possible, in certain cases, to obtain a variable annuity contract that does not include a surrender charge at all! This mostly eliminates the main obstacle to most annuity purchases: the worry that the client will need the money before the surrender period ends, and be forced to take a loss due to the penalty. In turn, this gives you more freedom to focus on what matters most, which is choosing a contract that will offer the greatest benefit over the long haul.
Of course, surrender-free contracts are not the norm, and in most cases you will have some period of time where a full withdrawal carries penalties. Check out all the options available before making a decision.
3. Will I be able to move this money?
A dramatic drop in the market will have an equally dramatic effect on the value of your contract. Naturally, your account value will fall, but the repercussions go beyond that. This has to do with the prevalence of income riders, also known as guaranteed minimum withdrawal benefits (GMWBs).
A large portion of the thousands of VA contracts purchased every month carry an income rider — an added benefit that provides a separate “account” that will increase at a guaranteed rate every year, and can never fall due to market performance. The exact percentage of VAs with this type of rider varies a bit depending on the source, but is generally agreed to be well over half; they are a fairly ubiquitous feature. When a lifetime income stream is activated, this income account is used to determine the size of the scheduled withdrawal.
If a large market drop occurs, the account value may fall dramatically, but the income account will remain where it is. Should you ever decide that you want to give up the contract and move the money elsewhere, you may find that your rider prevents you from doing so. This is for suitability reasons — a receiving company will be very unlikely to accept funds that come as a result of the client “giving up” a large income account, even if you submit a statement that they no longer want it. Markets can change a lot over a period of years, and this could mean that your clients are now in a contract that isn’t the most beneficial option available.
If you aren’t certain that you’ll want to use the funds for income and think you may want to move them to a different vehicle later, consider making some adjustments to your plan.
4. When will my client need income from this money?
Since variable contracts, like all annuities, are based around the need for lifetime income, it’s important to consider where the contract you are looking at fits into your plan to fulfill that need. Annuities have come a long way over the last couple of decades, and the days are long past when buying one just meant exchanging some cash for a stream of payments that stops when you die. While that’s still at the core of the product class, there are now myriad ways to take income from an annuity, and as such it’s important to consider which will work best for you.
The most common is the aforementioned income rider. Even within that group of products, however, there is a lot of variation, as many companies offer them and some even offer several. Choosing the right withdrawal method, then, becomes just as important as choosing the right accumulation method. Some are great for starting an income stream immediately, while others shine after a deferral period of five years or more.
It may also be that you aren’t selling this contract for an income need at all; along with all of the new ways to take income have come a multitude of uses for annuities that do not involve income at all. In that case, it might be best to forego a lifetime income option in order to eliminate the associated fee and thereby improve the yield.
5. Why is the carrier offering to buy out my contract?
In the years following the financial crisis of 2008, many annuity contract holders were wondering how they were going to retire on half of what they thought they had. That’s why it probably seemed like a godsend when their insurance companies started offering to buy out their contracts, surrender-free, for a big chunk of cash.
Should your clients receive such an offer, consider it carefully. If the company is offering to buy out that contract, it’s because they want to get rid of it. If that’s the case, it probably means the contract holder would be giving up something good.
Many of these offers came about due to the aforementioned frequency of income riders attached to VA contracts. By guaranteeing income based on a much larger number than what is currently in the account value, the carrier may find itself losing money on that contract. In that case, it makes sense to buy it out and take a smaller loss up front than to bleed “free” money to the client for years once the account value hits zero.
If you receive a notification that the carrier is willing to buy out the remainder of a client’s annuity contract, examine it carefully and weigh the benefits versus the costs before making a decision.
6. Am I being forced into an allocation?
Similar to the buyout offer, your clients may receive a notification from your variable annuity provider that their allocations are being changed. Depending on what changes are made, this can have a significant impact on how the contract value performs, particularly over a long period of time, as may be the case if that particular contract still has years to go on the surrender period.
The reason this may happen is again to stem losses that the carrier may be incurring on the current allocation; depending on the terms of the contract, the carrier may be able to adjust it to ensure that it remains financially feasible to keep it in force. While it’s tempting to label this as a “greedy” move by the carrier, it is important to remember that carriers issue thousands of contracts and are required by law to maintain solvency in the event that those contracts need to be paid out.
For you personally, however, this still means that you may be moved to a less-risky allocation that is not earning as much as the one you originally chose. If your client’s still ten years or more from retirement, this can make a big difference in the amount they eventually have to retire on.
When selling a VA, see if the contract states that the company can change your allocation later on. If you get such a notice on a contract that’s already in force, examine what your options are and if you should look at other options to get the portfolio your client needs.
